Tuesday, June 14, 2011

Our Economic Future: From Best to Worst Case

There is a great deal of uncertainty among investors about what the future of the U.S. economy may look like – so I decided to take a stab at what’s likely to happen over the next 20 years. That's enough time for a child to grow up and mature, and it's long enough for major trends to develop and make themselves felt.
I’ll confine myself to areas that are, as the benighted Rumsfeld might have observed, “known unknowns.” I don’t want to deal with possibilities of the deus ex machina sort. So we’ll rule out natural events like a super-volcano eruption, an asteroid strike, a new ice age, global warming, and the like. Although all these things absolutely will occur sometime in the future, the timing is very uncertain – at least from the perspective of one human lifespan. It’s pointless dealing with geological time and astronomical probability here. And, more important, there’s absolutely nothing we can do about such things.
So let’s limit ourselves to the possibilities presented by human action. They're plenty weird and scary, and unpredictable enough.

THE MARKET FOR PROGNOSTICATION

People are all ears for predictions, whether from psychics or from “experts,” despite the repeated experience that they’re almost always worthless, often misleading and more than rarely the exact opposite of what happens.
Most often, the predictors go afoul by underrating human ingenuity or extrapolating current trends too far. Let me give you a rundown of the state of things during the last century, at 20-year intervals. If you didn’t know it’s what actually happened, you'd find it hard to believe.1911— The entire world is at peace. Stability, freedom and prosperity prevail almost everywhere. Almost every country in Europe is ruled by a king or queen. Western civilization has spread to nearly every corner of the world and is received with appreciation. Stunning breakthroughs are being made in science and technology. There’s no sign of a gigantic world war about to come out of nowhere to rip apart the political and cultural map of Europe and bankrupt everybody. Who imagined that a dictatorial communist regime would arise in Russia?1931— It’s early in a disastrous worldwide depression. Attention is on economic troubles, not on the virtually unthought-of possibility that in less than 10 years a new world war would be under way against Nazism and a resurgent Germany.1951— Except for Vietnam, all that remains of the colonies the West had established in the 19th century are quiescent. Nobody guessed almost all would either be independent, or on their way, in 10 years. China has joined Russia – and many other countries – as totally collectivist. Who imagined that Germany and Japan, although literally leveled, would be perhaps the best investments of the century? Who guessed that the U.S. was already at its peak relative to the rest of the world?1971— Communist and overtly socialist countries all over the world seem to be in ascendance, soon to be buoyed further by a decade of rising commodity prices. The U.S. and the West are entering a deep malaise. Little significance is attached to rumblings from the Islamic world.1991— Communism has collapsed as an ideology, the USSR has disappeared, and China has radically reformed. Islam is increasingly in the news.2011—The world financial/economic crisis is four years old, but things are still holding together. Islamic terrorism and collapse of old regimes in the Arab world dominate the news. China is viewed as the world’s new powerhouse.

BAD AND WORSE

Regrettably, I’m not much of a linguist. But I do pick up interesting semantic trivia. In Spanish they don’t say “in the future,” as we do in English, which implies a definite outcome. Instead they say “en un futuro” – in a future – which implies many possible outcomes. It’s a better way of assessing reality, I think.
Here are three 20-year futures to consider. There are, obviously, many, many more – but I think these encompass the three most realistic broad possibilities.

BEST CASE – FACTS GET FACED

Realizing what a disaster the complete destruction of their currencies would be, most governments decide to endure the pain of allowing interest rates to rise and limiting increases in the money supply. Poorly run corporations and banks are left to fail. Talk of abolishing the Federal Reserve, and using a commodity for money, becomes serious and widespread.
Shaken, the U.S. ends its profligate ways, in part because it lacks the means to continue, and in part because everyone but collectivist ideologues has actually learned something from the brutal ‘10s and ‘20s.
Amidst massive protests, the government closes much of its counterproductive apparatus, eliminates many taxes, and lets 30% of its employees go. It also, albeit reluctantly, liberalizes its regulation of the economy because it has become impossible to deny that the U.S. has been falling behind in all areas.
Although there is a resurgence of libertarian thought – reminiscent of the Reagan-Thatcher era – simple practicality is mainly responsible for forcing the government's hand. For one thing, it can’t afford the bureaucracy needed to enforce detailed interference. For another, entrepreneurs are increasingly just doing what they please, partly from necessity and partly from a growing sense of righteousness. Interest rates go to 25%, to compensate for high levels of inflation. That's high enough to make it worthwhile for people to save, and the capital base starts growing. The stock market has collapsed to its lowest level in living experience (in real terms), but the values available encourage people to become investors. Business is restructured on a sound, debt-free basis, with little speculation.
The U.S. radically cuts its military spending and pulls almost all troops out of their foreign bases and wars. The War on Drugs comes to an end, and the crime rate in both the U.S. and Mexico plummets.
The government solves most of its overhanging financial problems with a seriously devalued – but not hyperinflated – dollar. The Social Security deficit is eliminated by abstaining from benefit increases and by inflating away much of what had been promised before. Most Americans suffer a severe drop in their standard of living, as they’re forced into new patterns of production and consumption. A generation of college students find that their degrees in sociology, political science, economics, English lit, Black studies, gender studies and underwater basket weaving are of no real value.
When it's all over, the tough times that started in '07 prove to have been no more than a cyclical bump in the road, like all the other recessions since WW2, just much bigger.
A rough and memorable ride, but it ends with a return to prosperity.

MIDDLE CASE – FACTS ARE IGNORED

The world’s governments continue under the delusion that printing massive quantities of paper money will solve problems when, in fact, printing lies at the base of the problems. Most currencies lose most of their value. Some lose it all. This destroys the most productive people in society, the middle class, who produce more than they consume and save the difference... in currency.
And it injures successful corporations that have billions, or even tens of billions, in cash. Few of their managers know what to do with such sums other than to hold currency; at best they’ll buy their own and other companies' stock. The result is a stock market boom in the midst of a grim depression. But only one person in a hundred will be in a position to benefit from it, because most will be living too close to the edge, and the stock market will be the last thing on their minds. The destruction of capital sets technology back quite a bit in the U.S., Japan and Europe. Chindia increases its relative strength.
The U.S. government, believing it has both the obligation and the ability to “do something,” redoubles its control of the economy. Price controls and capital controls are the order of the day. Petroleum products are rationed. Enforcement of new regulations is assigned to a new agency, the “Economic Recovery Administration,” which resembles the TSA in most regards – except it has many plain-clothes employees, to better ferret out violators.
People think increasingly of politics as the way to get what they want. More and more Americans move abroad – although things are deteriorating in most places in the world. Poor, backwater countries offer the best opportunities because their governments are either weak, or corrupt, enough to allow new economic activity.

WORST CASE – WAR

War is the worst thing that can happen to an economy, but it’s also the most likely thing at this point. When the going gets tough, the people in charge like to blame somebody else for the problem. That’s compounded by the foolish – but widely accepted – notion that war is good for the economy and that, for instance, it pulled the U.S. out of the last depression.
Like all wars, this one results in a complete stifling of civil and economic freedoms. If my second scenario is unpleasant, this alternative is grim.
The big conflict has already been teed up – the continuation of the Forever War between Islam and the West. I’ll hazard the major situs will be Europe – which has pretty much always been the case for wars in general for the last 2,000 years. Europe will be the worst place to be over the next two decades. And North America will be locked down like a police compound.
China will have serious social turmoil as it is forced to reorient an export-driven economy catering to Europe and the U.S. As in the past, South America will be out of the conflict and in a position to benefit from it. India will also be a net beneficiary, largely uninvolved, and happy to watch their ex-colonial masters rope-a-dope themselves into poverty.
People will always argue who really started it. Was it the Muslims when they poured out of Arabia in the 630s? Or was it the West when it invaded the Near East with the Crusades starting in 1099? Or was it the Muslims when the Turks took Constantinople in 1453 (although only 40 year later the Muslims would lose Grenada, in Spain, as the reconquista was completed) and then moved on to almost conquer Europe before being turned back at Vienna in 1683? Or is it more relevant just to look at recent history, starting at the beginning of the 19th century, when the West conquered and colonized every single Muslim country? Or the very recent past, when Muslims were counter-attacking, using a new military approach popularly called “terrorism”?
My bottom line is that the next twenty years may be dominated by the Forever War that started in the 600s, being resumed in earnest. At least in Europe, it has the prospect of becoming a war of survival, much nastier than either WW1 or WW2.
That resumption is being accelerated by what is going on in the Middle East now. The chances that the upheaval in the Arab world will just peter out and everyone will return to the status quo ante are about zero. It’s a culture-wide affair, much as the revolutions in Eastern Europe were. Or, for that matter, the revolutions against Spain in South America at the beginning of the 19th century.
The Arab revolutions are a good thing, in that they’re getting rid of criminal regimes. Some will be replaced with equally repressive cliques, although manned with different criminals. I suspect a few might be more like the French Revolution of 1789; good riddance to the old regime, but then came Robespierre. And after him Napoleon.
Regardless of how the tumult plays out in any particular country, the erstwhile docile collaborators with Europe and the U.S. are being elbowed aside, and the regimes that replace them are going to accommodate the vast public constituency for hostility toward the West, if only for the sake of internal political advantage.
The war is not going to be fought with conventional armies. First of all because the Islamic world doesn’t have any that would last more than a day or two against a Western army. But also because a Western army is useless against an amorphous mass of millions of people.
So what will the conflict be like? Amorphous and disjointed, chaotic and without fixed fronts. Millions of Muslims are in Europe – Pakistanis in the UK, Turks in Germany, North Africans in France, Indonesians in Holland. Europe’s destructive conquest of the world has come back to bite. These people will approach majority status over the next 20 years, both because they reproduce at several times the rate of the Europeans and because they’re not being absorbed. And because, now, millions and millions more are going to arrive as boat people.
The natives aren’t going to like it, for lots of reasons. And the outcome will likely resemble what always happens when large numbers of unwelcome foreigners invade a territory: violence.
One consequence of the war, and especially of the collapse of the regime in Arabia (in 2031 it’s no longer called Saudi Arabia, because the ruling Saud family – at least the ones who couldn’t get to their jets in time – has been massacred) is a cut-off of oil until the U.S. invades.
I hate to overemphasize oil, but the world still runs on it. When something does happen in Arabia, you can count on a disruption in the shipment of oil. And absolutely count on active U.S. intervention.
A prolonged guerrilla war, similar to those in Iraq, Afghanistan, Libya and other Arab countries will follow. But there won’t be any cover story about ousting a bad guy or bringing democracy to the oppressed. It will be pretty obvious to everybody that, from the West’s point of view, it will start out simply to answer the question: What’s our oil doing under their sand? But from the Muslim’s point of view, it will be a different question: How can we rid ourselves of these aggressive infidels once and for all? Then the West will rephrase their question to: These people want to kill us! How can we stop them once and for all?
You may be thinking that the U.S. can’t lose a war because it has a large and extremely high-tech military. All those expensive toys can be useful from time to time; they can win lots of small battles. But they’re basically useless for winning the next generation of warfare, as useless as cavalry in WW1, battleships in WW2, tanks in Vietnam or nuclear missiles today.
What? Nuclear missiles obsolete? Of course. They’re expensive, clunky, and the enemy can tell exactly where they came from. A plane, or a boat, or a truck – or a FedEx package – is a much neater delivery system. And there will be plenty of nuclear devices to deliver. If they’re within the grasp of tiny countries like Israel and North Korea, they’re within the grasp of anyone.
In fact, the centerpieces of today’s military are well on their way to the scrapheap or to museum displays. There may well be a few aircraft carriers, nuclear missiles, B-2 bombers, F-22 fighters, and the like around in 20 years. But they’ll be oddities reserved for special purposes, like typewriters. Laser, electronic and robotic weapons will have replaced those using gunpowder, and they’ll be readily available to anyone (an accelerant in the collapse of the nation-state). The military's reliance on centralization and on computer power will prove an Achilles heel; a gang of teenage hackers (not only the best kind, but the most common kind) can devastate a military for pure sport.
Conquest of wealth or territory will be pointless; that’s one thing even the Soviets suspected in the ‘80s, when they still had the power to invade Western Europe. It’s now nothing like in the old days, when a successful war yielded lots of gold, cattle and slaves. This lack of an economic return will obviate one reason for a military. The hollowing-out of nation-states will obviate another; governments will find they just don’t have either the financial means or the popular support for serious military establishments.
The military, as the cutting edge of the nation-state, is in serious decline. Conflict between groups will still exist, of course, but it will be more informal, more the kind of thing that a Mafia or an Al-Qaeda might conduct. The growth of private military contractors, like Blackwater (now Xe), which only need be paid when in use, is indicative.

A BASIC PLAN

Sorry I can't do any better than a best-case scenario that just isn't very rosy – at least over the near term. And there’s a high likelihood of the worst-case scenario. There will probably be some overlapping elements from all three, if I’m on the right track.
From an economic point of view, I see only two things as being predictable: One, that many people will always produce more than they consume and save the difference; this will create capital, which is critical for not only a higher standard of living, but for the advancement of technology.
Two, that since there are currently more scientists and engineers alive than have lived in all previous history combined, technology will keep advancing; technology is the major force to advance the general standard of living. So that’s essentially why I’m an optimist. Let’s just hope the savers aren’t wiped out, and the scientists don’t do too much government work.
The most sensible plan for the next 20 years is to plan to survive. The days of “He who dies with the most toys wins,” and of two whole generations living way above their means, are over.
20 years isn't forever. Think of it like a bear market, when the best thing to do is take your chips off the table, grab some books and retire to the beach for a year – except that this is going to be a lot longer and more serious. Nonetheless, I expect my fundamental optimism to get through it undamaged, as should yours.
For one thing, the long-term trend is favorable. Mankind has risen from subsistence and living in caves as little as 12,000 years ago, to reaching for the stars today – and the rate of progress has been accelerating. Why should that stop now?
But, as I mentioned earlier, thinking too far in the future is perhaps pointless. So what should you do now? The essential advice remains the same:

Own gold and silver. At Casey Research, we’ve made a lot of money on them – and they’re no longer cheap – but they’re going higher, simply for lack of alternatives. Look at them as you would cash.

Produce more than you consume, and save the difference. This is no longer the time for promiscuous, conspicuous consumption.

Be alert for speculations. Some markets will collapse (for instance, I wouldn’t want to own a McMansion in the suburbs or a “collectible” car). Other markets will likely turn into manias, benefiting from trillions of new currency units (I suspect mining stocks will be one of them).

Diversify your assets (and yourself) politically and geographically. As big a risk as the markets will be, your government is an even bigger one.

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